3 main reasons why Puerto Rico can't declare bankruptcy

How do we solve Puerto Rico's debt crisis? As Americans — both
Puerto Ricans and citizens of the 50 U.S. states and the District
— watch as Greece stumbles ever deeper into economic catastrophe,
many of us want to know what our government plans to do about the
Puerto Rican debt crisis, which, whether one likes it or not, is
America's problem.

A "bailout" is simply unacceptable to U.S. taxpayers. But a
solution that provides fairness to creditors as well as debtors
is at hand, if Congress is prepared to deploy its readily
available constitutional powers. The Commonwealth of Puerto Rico
should be authorized to restructure all its debts in a federal
bankruptcy court.

On June 29, the governor of Puerto Rico announced that $72
billion of the commonwealth's debt was "unpayable." This debt
burden amounts to more than $20,000 for every man, woman and
child — or roughly 70 percent of the commonwealth's per-capita
gross domestic product. It is thus no exaggeration to
characterize this as the most drastic fiscal crisis in Puerto
Rico's history. This crisis threatens to inflict grave harm on
the 3.5 million U.S. citizens of Puerto Rico, but also on the
U.S. economy at large.

One proposal seeks to allow Puerto Rico's public utilities to
declare bankruptcy, as they could if they were the
instrumentalities of a state, rather than a territory. About
one-third of Puerto Rico's debt burden is owed by such utilities.
Chapter 9 of the U.S. Bankruptcy Code allows municipalities, with
their states' permission, to restructure their debts through
bankruptcy. "Municipalities" have long included public utilities
of the type facing insolvency in Puerto Rico.

However, the code allows only the municipalities of
states to declare bankruptcy. A bill proposed by Puerto
Rico's nonvoting delegate in Congress, Pedro Pierluisi, would
address this gap in the law by amending the code to allow Puerto
Rico's utilities to enter Chapter 9. While the bill has stalled
in the House, Sens. Chuck Schumer (D-N.Y.) and Richard Blumenthal
(D-Conn.) recently introduced a similar bill in the Senate.

Such a solution has obvious appeal. It is straightforward and
satisfies our basic commitments to uniformity and equality. There
is no reason to withhold from the municipalities of the
territories the same options in bankruptcy that are afforded
those of the states.

Sadly, though, the Pierluisi bill does not go far enough. A
significant portion of Puerto Rico's $72 billion in bonds were
issued directly or indirectly by the commonwealth government, not
by public utilities. A solution that addresses less than half of
the total debt would simply kick the can down the road, leaving
Puerto Rico with crippling payments on the other two-thirds and
predictably smothering the economic growth that should be the
goal of all concerned.

Reuters/Ana Martinez

Meanwhile, others, including some of Puerto Rico's creditors,
have proposed a federal "bailout" for Puerto Rico, along the
lines of recent bailouts of banks and auto companies. It goes
without saying that this solution is contrary to the interests of
the U.S. taxpayer. But it is also not in the interests of the
people of Puerto Rico because it would arguably reward undue
risk-taking and do nothing to get Puerto Rico's economy back on
its feet.

There is a much simpler and more orderly solution that is well
within Congress's constitutional authority over territories:
Congress can and should allow all of Puerto Rico's debt —
including its general-obligation bonds and pension obligations —
to be restructured through bankruptcy.

Our federal bankruptcy system is designed to protect the
interests of all relevant parties, including Puerto Rico's
creditors, and has the power to ensure that these debts are
restructured through a fair and binding process. This solution
has the best chance of helping Puerto Rico work itself out of
this crisis.

So why not let Puerto Rico declare bankruptcy? There are three
main objections to this plan. All seem reasonable but are easily
countered.

First, there is the constitutional argument. The Bankruptcy Code
does not permit states to declare bankruptcy, in part, because
subjecting them to federal bankruptcy or to suits from creditors
arguably runs afoul of the 10th and 11th amendments.

Puerto Rico, however, is a territory, and the Constitution gives
Congress the power to "make all needful Rules and Regulations"
respecting the territories. Congress, therefore, has authority to
extend the provisions of the Bankruptcy Code to Puerto Rico, and
these provisions would have primacy under the Constitution's
Supremacy Clause.

A
man waves a national flag as others stand nearby during a protest
in San Juan.Reuters/Alvin
Baez

Second, there is the "moral hazard" argument. Why should we
reward Puerto Rico and its residents for living beyond their
means? To be sure, Puerto Rico has contributed to its problems by
borrowing profligately to fund its bloated public payrolls. And
Congress should consider imposing public-sector reform as part of
any debt-restructuring legislation. In some ways, Puerto Rico is
here the victim of its territorial status: Puerto Rico is part of
the United States, and so it has no monetary policy of its own
and is thus limited in how it can respond to a debt crisis.

The best response to the "moral hazard" argument, however, is
that the bankruptcy law enshrines our pragmatic recognition that
a debt burden can become too crushing to handle. Although it is
preferable for people, corporations and cities to make good on
their obligations, in some cases this becomes practically
impossible, to the detriment of creditors as well as debtors. The
purpose of bankruptcy is to allow debtors and creditors to enter
into an orderly and binding system of adjudication, where such
debts can be restructured.

Finally, there is the concern, shared by many Puerto Ricans, that
treating Puerto Rico differently from the states is inconsistent
with future efforts to achieve statehood. In short, if states are
not permitted to declare bankruptcy, then Puerto Rico should not
be permitted to do so either.

In Puerto Rico, this concern is motivated by profoundly
pro-American sentiments and a yearning for full equality within
the American political family. But the simple reality is that
Puerto Rico is in desperate trouble now, and it is a territory
now. Nothing that happens today with respect to the current
crisis should affect any eventual movement toward statehood, nor
necessarily affect how states are treated in bankruptcy. In
attempting to resolve this serious crisis, Congress should
therefore be encouraged to consider the full range of its legal
options.

A clear-eyed view of the crisis reveals that the best solution to
this difficult problem is to allow Puerto Rico and its creditors
to restructure all these debts through the U.S. Bankruptcy Code.
This step would both extend the protections of bankruptcy to all
of Puerto Rico's creditors and give the U.S. citizens of Puerto
Rico their best chance to move beyond this crisis and toward a
better future.